Why the IMF’s so hard on Greece

Dominique Strauss-Kahn thought he was saving the world. Christine Lagarde can only hope she’ll be saving her job.

The impact of the International Monetary Fund’s involvement in the Greece bailouts may have had different consequences for the institution’s’ last two managing directors. But the main consequence of its controversial action since 2010 seems clear: For the Fund’s involvement in eurozone affairs, it looks like “never again.”

Strauss-Kahn, during the trial on pimping charges for which he was recently cleared in France, explained to the judges that he couldn’t have possibly attended as many sex parties as alleged by the prosecution because he was “busy saving the world.” He was the IMF’s managing director in 2010 when the Fund was called to help the eurozone devise a way to bail out Greece.

DSK’s successor Christine Lagarde, for her part, must deal with the consequences of what was a controversial involvement from the start. She has to soothe a restless IMF board where representatives of emerging countries resent the Fund’s involvement in the never-ending Greek crisis, for which it bent, if not broke, most of its long-standing rules of engagement.

That may be the reason why Lagarde is appearing to be tougher with Greece than its eurozone creditors — save possibly Germany, whose finance minister Wolfgang Schäuble remains highly skeptical of Greece’s ability to ever solve its own problems.

That is showing again this week with the IMF taking a hard stance against the most recent Greek proposals that Eurozone ministers and the Commission greeted favorably last Sunday. According to a French official, IMF negotiators have raised doubt on both the principle and the feasibility of Athens’ suggestion to raise taxes in order to finance its pension systems. The Fund has always preferred spending cuts, deemed growth-friendlier than tax hikes. And in any case, due to the dysfunctional nature of the Greek state, it doesn’t trust the capacity of the current government to collect the taxes it wants to raise.

Lagarde comes up for re-election as IMF head next year. She can’t afford a split board. The European stranglehold on the IMF’s top job since its creation is being contested, and she has to show she can be tough on Europe.

That involves both being tough on Greece — making sure Athens adheres to a credible program — and being tough on Greece’s creditors, by pointing out that they will have to consent to debt relief in future. That’s where the IMF disagrees with Germany, whose finance minister Wolfgang Schaüble, a supporter of the IMF stand on the Greek plan, doesn’t want to hear about debt relief for now.

Looking ahead, Lagarde has until March 2016, when the current IMF program for Greece expires, to extract the institution from the Greek mess it regrets having ever stepped into.

The IMF’s role in Greece has been “one of the most credibility-sapping in its history,” noted Gabriel Sterne, a former Fund staffer who is now chief economist at Oxford Economics, in a scathing note published last year. IMF insiders and most economists tend to agree.

The main cardinal sin against its own rules that the IMF committed, as soon as Greece got its first bailout in 2010, was to agree to a program that didn’t and couldn’t guarantee the country’s long-term debt sustainability.

Code for “contagion”

Any IMF program must supposedly find a balance between the “adjustment” — which almost always means austerity — required by the Fund and the financing it provides in exchange. It almost always involves a currency devaluation and at times some form of debt restructuring.

Because Greece was in a monetary union, and couldn’t devalue its currency, the IMF introduced a “systemic exemption” that waived any condition related to debt, says Jean-Pierre Landau, who was then a deputy governor of the French central bank and now teaches at Sciences Po in Paris.

That was “a code word for the risk of contagion inside the euro area,” he notes. The IMF board, right from the beginning, found it hard to accept and “it created resentment and a lot of skepticism” within the institution, adds Landau, who knows the IMF well, having been its French board member in the early nineties.

The Greek bailout also created a precedent in terms of size. It was the largest ever implemented by the IMF, as a percentage of a given country’s stake in the Fund. Between the first and second bailout in 2012, the IMF ended up loaning about €30 billion to Greece. Some €23 billion is still owed, to be paid back until the end of 2030, starting with €5.5 billion due by the end of this year.

Then there were the forecasting mistakes. Sterne notes for example that the IMF revised down its estimate for Greece’s 2014 gross domestic product by some 22 percent in the space of 18 months. “In U.S. terms, that is the equivalent of revising away the combined output of the whole of California, New York and Florida,” he writes.

The IMF wasn’t the only institution forced to revise its forecast down throughout the long euro slump. But it was the only global body whose own money was at stake. When assessing Greece’s debt sustainability, the IMF famously put in a debt-to-GDP ratio of 120 percent by 2020. It now stands at some 175 percent, with little chance of coming down to that level within the next five years — unless there is a serious debt write-down by eurozone creditors.

Back in 2010 not everyone agreed the IMF should get involved in Greece. Jean-Claude Trichet, then president of the European Central Bank, fought tooth and nail to keep the Fund out. The eurozone, he thought, could deal with the problem on its own. Some of his former associates say today that Trichet lived the IMF’s participation in the first bailout as “a personal humiliation.”

But German Chancellor Angela Merkel was adamant that only the IMF had the expertise to devise and monitor a serious turnaround economic program for Greece.

Too little, too late

The Fund not only brought money — much less in total than eurozone members — but the “bad cop” mentality Merkel felt was necessary to force Greece to reform. Strauss-Kahn, who at the time was still harboring ambitions to run in the 2012 French presidential election, may also have hoped to benefit from a determined IMF action to help solve the euro’s problems.

Partly because of that, French President Nicolas Sarkozy — whose finance minister was … Christine Lagarde — wasn’t keen to shore up a possible rival and see the IMF intervene, but he finally relented to accommodate Merkel.

The extent of the IMF’s Greek mistakes are part of the reason it felt necessary to apologize back in 2013, notably for its former light-hearted estimate of the negative consequences of fiscal austerity coupled with a credit crunch.

In June, 2014 the IMF also circulated a paper outlining a new approach to dealing with sovereign debt — broaching the possibility in the future of demanding what it called a “reprofiling” of a country’s debt as a condition for its aid.

The idea is to avoid contributing “too little, too late” to resolve debt crises. For Greece, of course, the new thinking is definitely too late. And Lagarde is now facing unattractive scenarios.

If Greece doesn’t reach a deal with the rest of the eurozone this week, there is a strong likelihood that it won’t be able to pay the IMF the €1.6 billion it owes at the end of June. Defaulting on an IMF loan is a rare event, which only three small war-torn countries — Somalia, Sudan and Zimbabwe — have done until now. There would then be a good chance that the IMF might have to forego the whole €23 billion it is still due.

A deal this week, on the other hand, would allow Greece to pay its June bill to the IMF but wouldn’t dispel uncertainty over the rest of the loans. Athens faces sizeable (€1 billion-plus) annual IMF reimbursements until 2023, when they then dwindle down to manageable amounts.

IMF loans cannot in principle be restructured or undergo a “haircut,” so in case of default Lagarde will have to explain to her board why and how the money evaporated. And, to the governments of big emerging economies such as Brazil or Mexico, why their money was used to bail out the Greeks, whose GDP per head remains far higher than theirs even though it has fallen 25 percent since 2009.

So don’t expect the IMF to ride to the rescue next time a troubled eurozone economy is teetering on the brink. “They bent their rules to prop up a political construct like the euro. They’ve been burnt once, so they’ll think twice before they become involved again,” sums up Robert Kuenzel, head of economic research at Daiwa Capital Markets.

Nor will there be much enthusiasm at the IMF to take part in a third Greek bailout, if it proves necessary. For now, Lagarde’s priority looks relatively clear: To get her money back.